U.S. corporations continue to buy back stock at a near-record pace. Purchases could ramp up after earnings season blackout periods end.» Read More
Rate hike in June? Forget about it.
I know, removing the statement that there would not be a rate hike in the next meeting theoretically still holds out the possibility there could be a hike in June.
But read the statement: this seems like a very small chance.
The Fed has told us when they will raise rates: 1) when it has seen further improvement in the labor market; and 2) when it is reasonably confident that inflation will move back to its 2 percent objective in the medium term.
In the statement, the Fed said that:
1) job gains have "moderated," economic growth "slowed," with growth in household spending declining and business' fixed investment softening, and repeated the housing recovery remains "slow;"
2) inflation is anticipated to remain low (below its 2 percent objective) for the near term.
In other words, the Fed has offered a fairly dovish (cautious) view of the economy, and inflation is also below its targets.
That sounds like a June rate hike is off the table.
Is there anything that could change this? We would have to have some bullish—and I mean really bullish—economic reports by now and the June 17 Fed meeting.
Specifically, April and May nonfarm payrolls would have to be up—big time. And March, which was a disappointment at 126,000, would have to be revised upward significantly.
We'd also likely need to see evidence that the rest of the economy is rebounding...that GDP is closer to, say, at least 2 to 2.5 percent rather than the 0.2 percent in the first quarter.
Finally, we'd need some darn fast moves up in the inflation indicators.
Doesn't this all seem a bit unlikely? I mean, I know the Fed loves to use the word "transitory factors" but betting on a June hike seems to be stretching credulity.
A strange morning of trading, with the German stock market down big (about 3 percent), German bunds rallying big, euro rallying big, oil rallying big.
The simple way to understand this is to know where the market is. In general, market participants are:
1) Long the dollar
2) Long Germany
The really weak economic numbers—particularly the disappointing GDP—implies those two trades could be coming a bit unwound:
Weak GDP = Fed is slower to raise = weaker dollar/higher euro = foreign exchange headwind for German exports = bad for German stock market.
The implication for stocks is that other long plays could be under pressure. What is the biggest gainer this year? Healthcare, in particular, biotech.
But biotech has been volatile. We have seen significant gains in other healthcare sectors this year, and that too is coming under some pressure. In the U.S. markets, we have a new route going on in healthcare, but not just biotech: Medical equipment makers like Stryker, labs like LabCorp, hospitals like Tenet, and HMOs like Cigna are all down 2-4 percent.
Of course, this doesn't explain everything. We also had a huge runup in German bund yields, up 12 basis points to yield 0.28 percent. The rally in yields began at the open in Europe and continued through the close. Traders blamed some of this on Jeff Gundlach's comments that he might make an amplified bet against German bunds. A German auction of five-year notes also did not go well.
What we need now is the Fed to put it all in perspective.
S&P futures were weaker ahead of the first quarter GDP report, dropped about 4 points immediately after and then bounced. That's a fairly modest response.
Bulls argue that a weak first quarter GDP—which showed the economy grew at just 0.2 percent—was well-telegraphed and that the question is to what extent we'll get a bounce back in the second quarter.
Peter Boockvar, chief market analyst at the Lindsey Group, this morning noted that hopes for 2 percent-type growth for the full year was still alive, but 3 percent was now highly unlikely.
What does this mean for the Fed meeting that concludes Wednesday? My bet is the members will recognize the weakness of the economy, but will say that many of the forces responsible for the poor showing—weather, low oil—will likely be "transitory."
The third factor, a strong dollar, may also be transitory if we continue to get these lousy numbers.
But the entire healthcare complex is weak Monday: medical equipment companies like Stryker, hospitals like Tenent , HMOs like Healthnet or drug distributors like Cardinal Health are all down 1.5 to 3 percent.
This isn't too hard to figure out: biotech is the highest profile subsector of healthcare. Healthcare is the best performing sector of the S&P 500 this year (up over 7 seven percent), so the consensus among traders is there's a bit of "sell the leader."
Which brings me to why Biotech is so weak Monday. The main issue is that this is the biggest leveraged long play on the Street.
With that understanding, I see several issues:
1) God help you if you disappoint. Did you see Celadon Monday, a smaller biotech that is down 80 PERCENT on the failure of its gene-therapy drug Mydicar for heart failure? Or Aerie Pharmaceuticals , which is down more than 60 percent in the last two trading sessions after announcing that its lead product, a treatment to lower eye pressure in glaucoma patients, had failed to meet its objectives in a late-stage trial. Biogen also had disappointing earnings at the end of last week.
2) Mylan rejecting the Teva offer is certainly taking some of the takeover premium out of the healthcare sector, but I think another soured deal is just as important: Applied Materials announcing it was calling off its merger deal with Tokyo Electron, due to problems with the U.S. Department of Justice.
This was an even bigger surprise than Mylan. There were a lot of traders long AMAT.
My point is this: killing both of these deals is causing de-risking in other sectors and stocks where there are "consensus longs."
Finally, the big-cap S&P 500 has joined the small cap Russell 2000 in record-closing territory. This is a great relief to everyone who worried that the market could not possibly advance once the Fed stopped its quantitative easing program, and certainly not within a few months of the Fed raising rates, which certainly seems like a strong possibility.
With the Federal Open Market Committee meeting this week, the big issue is, how will the central bank characterize the economy? Will the Fed statement be enough to get us decisively out of the trading range we have been in?
The economic data has certainly been choppy, with first quarter GDP now expected to grow a measly 1 percent.
However, I think there is a good chance the Fed will say the three factors that have been moving markets—weather, weak oil and a strong dollar—are all likely temporary, and are now reversing.
That may increase the chances of a September rate hike (I think likely) but it will also take some pressure off the recent worry about earnings.
Indeed, they are reversing: West Texas Intermediate crude oil is near its high for the year, while the dollar's rise has stopped and even declined since peaking in mid-March.
The strong dollar in particular has been a mess for multinational companies. Just look at the difference in earnings between the big-cap S&P 500—where many companies get more than half of their revenues overseas—and the small-cap S&P 600, where most get little if any revenues overseas:
S&P 500: down 3.4 percent
S&P 600: up 5 percent
We are talking about a difference of more than 8 percentage points!
Competition in stock exchanges coming.
It's been known for some time that dark pool IEX, which was prominently featured in Michael Lewis' "Flash Boys" book, aims to become a stock exchange later this year. It will be known as Investors' Exchange.
Late last night Patrick Healy announced that he would be joining IEX. Healy ran Issuer Advisory Group, which advised companies on where they should be listing and also acted as a general advocate for those companies.
Healy didn't say what he will be doing, but it's pretty clear that Investors' Exchange is bringing in Healy to get new listings for the nascent exchange.
Despite the weak equities business, NYSE/ICE still gets a significant portion of its revenues from listings (about 12 percent), so this is a sign that Investors' Exchange is going to be going after the listings business of both NYSE and Nasdaq.
Separately, BATS Global Markets, the third exchange, this week hired Laura Morrison, who until last week was the NYSE's head of ETFs.
New BATS CEO Chris Concannon has made no secret that he wants to beef up his ETF trading business (several ETFs already list on BATS), and this is a sign he is very serious about increasing the already substantial trading of ETFs on BATS.
Competition is alive and well in the equity space!
Still, you can't help but notice the continuing impact of the strong dollar on revenues. Here's Amazon and Google's revenues, then reported in constant dollars:
These are huge differences, 7 percent in the case with Amazon. With Amazon, you're dealing with $22 billion in sales for the quarter. Google reported revenue of $14 billion.
Starbucks, which reported an amazing 18-percent increase in revenues, noted that its EMEA (Europe, Middle East, and Africa) segment reported net revenues down 10 percent, largely due to "unfavorable foreign currency translation."
Breakout! S&P 500, Nasdaq, and S&P Midcap are poised to close at historic highs.
All year, there have been groans from the trading community on the technicals: 1) we're in a trading range! 2) the volume is terrible! 3) there's no volatility!
It's true we have been seeing low volume and low volatility, but we are on the verge of breaking out of a trading range we have been in all year.
Then there are groans on the fundamentals: 1) the valuations are high!, 2) the economic data is not as strong as it should be! 3) earnings are poor!
But I'm not sure that gets you to a change in direction. I'm not sure this alone means we are on the cusp of a lasting bear market.
What about earnings? Here, I am concerned by the prospects of at least two, and possibly three, quarters of flat to down earnings growth, on top of negative revenue growth from the strong dollar.
But can we make a CONVINCING case that earnings are peaking? Right now, we can certainly argue that earnings have stalled, largely due to strength in the dollar and weakness in oil.
But I'm not sure this is the start of some kind of secular decline in earnings.
Two final points: 1) market psychology remains bearish. You don't usually get a major market peak with this kind of psychology, often considered the most hated stock rally of all time. You usually get a lot more exuberance.
2) There is no alternative to stocks. Every trader I talk to says, what will do with our money if we sell stocks? The alternatives are so unpalatable that it makes the bar much higher for the bears. It takes a lot more to convince people.
So, for the moment, I am not willing to call a market top.
Traders are getting disappointing economic reports from Japan, China, and the euro zone.
I thought a weaker euro would support exports? Yet eurozone PMI data was below expectations, as new orders slowed.
And what about China? Its PMI fell to its lowest level in a year, to 49.2 from 49.6 in March. A reading below 50 indicates contraction.
That means more stimulus. On Sunday China's central bank cut the reserve requirement ratio for banks, which frees up more money for lending.
It sounds like a cut in interest rate is coming next.
This was a bit of a curve ball. Five years after the flash crash, the Commodities Futures Trading Commission has filed a civil complaint alleging a man named Navinder Sarao manipulated the Chicago Mercantile Exchange's E-mini futures contract by using spoofing tactics, that is, efforts to place and cancel hundreds of thousands of orders with no intention of executing them.
This apparently went on for some time, beginning in June 2009, and lasting intermittently until the present.
What's getting attention is the CFTC is alleging that Sarao was active on May 6, 2010, the day of the flash crash.
Simply put, they are alleging that Sarao used a "layering algorithm" that set large sell orders in the E-mini order book, all at different price levels above the best asking price. There was very little chance the orders would ever be executed because they all kept moving as the market moved, but because these orders were so large they allege he was as much as 40 percent of all active sell-side orders on some days.
Now to the manipulation part. They allege he overloaded the sell side, which lowered prices. Then, when he stopped overloading the sell side (when he turned the layering algorithm off), the price rebounded. He profited from this temporary price volatility by trading the E-mini contracts. His daily profits on 12 specific days he was active, including the day of the flash crash, was approximately $6.4 million, or $530,000 a day.
There are additional spoofing allegations, but you get the point: Sarao attempted to cause a price drop, then took advantage of the drop by repeatedly selling the E-mini contracts and buying them back at a lower price. When the layering algorithm was turned off, he bought and sold the contracts as prices rebounded.
Bear in mind, there's nothing wrong with layering an order book with sell orders. Traders do that all the time.
However, it is different if you are putting out orders that represent false supply that is pushing the market down to cover your short orders. These were not bona fide orders, the CFTC is alleging. He had "cancel and close" orders, that is, as soon as the market came close to the order, it was cancelled.
It's not just the scheme, it is the size of it: on many days, the CFTC alleges that Sarao accounted for approximately 20 percent of total sell-side orders, and sometimes as high as 40 percent.
On the day of the flash crash, the CFTC alleges, Sarao put in orders representing about $170 million to $200 million in the morning and early afternoon, representing 20 to 29 percent of the sell-side order book. The orders were replaced or modified more than 19,000 times before being cancelled at 1:40 p.m., Central Time.
The CFTC's point: Sarao was at least partly responsible for the severe imbalance between buy and sell orders that was believed to be a major factor in the flash crash.
The SEC, in its report on the cause of the flash crash, named several factors, but also placed significant blame on an imbalance between buy and sell orders that caused a dramatic drop in liquidity on both the E-mini futures contract and the S&P 500 ETF.
However, a principle reason for the imbalance, the SEC report said, was that a large fundamental trader of a mutual fund complex initiated a program to sell a total of 75,000 E-Mini contracts (valued at some $4.1 billion) as a hedge to an existing equity position. The "mutual fund complex" sold these contracts with little regard for price or time... it just executed the order very quickly.
In other words, the "mutual fund complex" used a lousy algorithm. This caused a severe imbalance between buy and sell orders.
This is what bugs me: the SEC says this lousy algorithm sold $4.1 BILLION in E-mini futures. That makes the $170 million-$200 million in sell orders that Sarao allegedly put in seem like small potatoes. And remember, Sarao's orders were cancelled!
What's this all mean? My first reaction is, what took them so long? Five years to look into this? Even with the understanding that researching this kind of stuff is very difficult, it was an absurdly long time.
Second, looking for a single cause of the flash crash is fruitless. As Dave Lauer at KOR Group has noted many times, the stock market is a complex system.
All we can do is talk about contributing factors:
1) There was great fear on that day about the European debt crisis, with the euro going into a sharp decline about 1 p.m., Eastern;
2) there were very severe buy and sell imbalances midday, which were likely caused by several factors and participants;
3) liquidity dried up as some participants chose to back away from trading, or route orders to other venues;
4) market structure was rickety, with circuit breakers differing between the exchanges.
One thing is pretty clear: regulators need to get more sophisticated in how they analyze the market. How? Lauer (who has founded Healthy Markets, a nonprofit advocacy group for market structure reform) and others have described what is needed: take the data from the equities, futures, and options market, including dark pools and hidden orders, then have everyone synchronize their clocks to the microsecond, so everyone is on the same time.
Then you have a quick, easy way to find and police the markets quickly. You can't now because the data is in a million different places, with different time stamps. And no one knows what they're looking for!
The U.S. top court ruled against a man, saying he couldn't appeal a court rejection of his bankruptcy plan.
A glum Bill Gross sees both himself and the bull market facing the same long road to oblivion.
U.S. corporations continue to buy back stock at a near-record pace. Purchases could ramp up after earnings season blackout periods end.